Why Your Disability Insurance Plan Might Suck

If you're a dentist and your hand is injured, you could be disabled. If you have fingers amputated, you have a lifetime disability. What to do?

Hopefully, you have disability insurance, either through a group/employer, or individually. Let's explore the basics of disability insurance, including a few things to beware of.

DISABILITY INSURANCE BASICS

Disability Insurance pays a monthly stipend replacing about 70% of your income for the duration of your disability (or terms of the policy) due to illness or injury. Multiple factors affect your payout, which we'll explore below.

Potential Payout for Disability Insurance

Your greatest asset is your ability to earn income. And your greatest financial risk is a disability. For example, if you make $30,000/year at age 25 with 2.5% increases annually, by the time you reach age 65 you'll have earned over $2 million dollars.

Your risk of getting a disability versus dying is 10-1 at age 35.

What You'll Need the Money For

Disability Insurance is an income replacement tool. Not only will it help with living expenses, but you might also have additional medical expenses not covered under your health plan.

Bob gets a heart attack, and has open heart surgery. He's away from work for six months, but has a relapse requiring more surgery with complications. Bob could be off work for a long time - in fact he may never be able to return to work, nor can he work at most other jobs. With a family to support and a mortgage to pay, you can imagine the havoc this wreaks on finances.

STRUCTURING YOUR POLICY AND APPLYING

There's a lot of flexibility in the structure of your disability insurance policy. Your monthly benefit can start from immediately to two years after diagnosis (the longer the waiting period the cheaper your premiums), and the monthly benefit amount can last from two years to age 65 - or until you're able to work again, whichever happens first (the longer the benefit period applied for, the more expensive your premiums). Your ability to apply - and the premiums you pay - are dependent on your job, state of health at application, and income.

Three Definitions of Occupation

This is where disability insurance gets sticky with terminology. There are three definitions of occupation that can make - or break - your policy:

Any Occupation - This is the least expensive (and most dangerous) option. If this definition is in your policy, the insurance company will only pay disability insurance benefits if you're incapable of performing "ANY occupation" for which you have the skills, training, or capability of being trained for. To take this to extremes, you could be paralyzed from the neck down, but if the insurance company deems you capable of selling widgets over the phone, you won't receive disability benefits.

Regular Occupation - This is the most common policy type; the insurance company pays if you can't perform the duties of your "regular occupation". So if you can't work at your job (or one similar to it, in the same industry) you'll receive disability payments.

Own Occupation - This is the most expensive, usually purchased by people in highly specialized (or high-income) careers. If you can't perform your job in your specific occupation, the insurance company pays out. For example as a specialized dentist, if you can't attend to your patients in your clinic, you'll receive benefits - even if you could potentially perform another form of dentistry in another setting or area of specialty.

Short-Term vs Long-Term Disability Insurance

Short-term disability insurance (STD) kicks in immediately after your disability, and usually pays out for three to six months. It's generally very expensive for individuals (although it may be part of your group insurance plan through work). It can usually be circumvented with emergency fund planning.

Long-Term disability insurance (LTD) is more common, with payments starting on average 90 days after your disability begins, paying out anywhere from two years or up to age 65. If you have both STD and LTD, the LTD will be designed to start when the STD ends.

Group Insurance Pitfalls

Many people have disability insurance through work. However beware: if your group policy is only LTD, has a waiting period of six months before payments begin, a payout period of two years, and "any occupation" as the definition of occupation, then the policy might not be very useful.

Also, if your employer pays the premiums and deducts them from their taxes, then your disability benefit (a maximum of 70% of your income to begin with) will be taxed. It's better to pay the premiums yourself with after-tax dollars, so the benefit paid out is tax-free.

Check out the fine print of your disability insurance policy; does it suck?

Nora Dunn is The Professional Hobo: a full-time traveler and freelance writer.Having sold her business and belongings to travel, she has been on the road since 2007. She travels in a financially sustainable manner, specializing in creative travel strategies like getting free accommodation and flying in business class for less than economy prices; all the while earning income with her location independent career.

As a former Certified Financial Planner, she is financially responsible for her actions along the way. She believes there is a fine balance between planning for tomorrow, and living for today.